Why property prices did not fall enough in 2008

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The real estate industry may have run into fresh trouble. Having emerged fresh from a crisis that threatened to take a few companies belly up, the worst was perceived to be over for the industry.

However, data that emerged from a recent Reserve Bank of India (RBI) document shows that just when the industry was in the throes of the downturn in 2008, banks stepped in to lend generously when they needed capital to survive, saving developers the trouble of cutting prices to stay afloat.

Here's a background of events: Property prices in India, especially in metropolitans, rose rapidly between 2003 and 2007 till the point of reaching unaffordable levels, when demand soon began to taper off. Between those years, the perceived bullishness over the sector prompted developers to rush to the stock exchanges to raise money and further expand business. In order to list, these companies got into a race to buy land at exorbitant prices, thus pushing prices further up.

However, when the global financial crisis hit home in 2008, demand for property nosedived. Real estate stocks were chosen out by the stock market for special punishment, losing anywhere between 70% and 90% of their market capital.

Funds for the industry, a capital-intensive one, dried up and had it not been for banks that stepped in to lend, builders would have not had an option but to cut property prices to sell inventory and raise cash. Property prices in the country did correct between 20-40% depending on the location, say experts, between May 2008 and May 2009, after which they're seen heading up again.

The big bank bailout?

Now, here's the hard data: as per the RBI document, loans to the real estate industry grew as much as 41% last year even as loans to homebuyers grew about 5% in the same period, confirming the trend that demand for property was indeed down.

In fact, in the monetary policy review that the central bank came out with earlier this week, it made loans to the realty industry stricter and ordered banks to arrange for coverage should any of their loans default and get classified as non-performing assets (NPAs).

Chetan Ahya of Morgan Stanley says that the real estate industry got easy lending from banks, due to which they were able to hold back sales and not cut property prices too much. "The RBI governor, post the monetary policy, was clear the RBI would like to see more adjustment in the property sector on the pricing front and that there should not be aggressive price increases," he said.

Developers, though, were not pleased and on the contrary said the RBI move could result in project delays and make property costlier or impact their margins.

"Property prices are a function of the market, supply and demand. Therefore it at all the hit has to be taken and the prices cannot be increased it would obviously impact the margin," said Pujit Aggarwal, Managing Director of Orbit Developers.

With the RBI turning on the heat on real estate companies, what will the outcome be on the industry and property prices? Time will tell.

- With inputs from CNBC-TV18